Riding Into the Sunset

Riding Into the Sunset

It is time for a serious solution to the problem of retirement
security.

June 9, 2005

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The Geezer Threat

In 1900 Americans on average lived for only 49 years and most working people died still on the job. For those who lived long enough, the average “retirement” age was 85. By 1935, when Social Security was enacted, life expectancy had risen to 61 years. Now it is 77 years–nearly a generation more–and still rising. Children born today have a fifty-fifty chance of living to 100. This inheritance from the last century–the great gift of longer life–surely represents one of the country’s most meaningful accomplishments.

Yet the achievement has been transformed into a monumental problem by contemporary politics and narrow-minded accounting. “The nation faces a severe economic threat from the aging of its population combined with escalating health costs,” a Washington Post editorial warned. Others put it more harshly. “Greedy geezers” are robbing from the young, bankrupting the government. Painful solutions must be taken to avoid financial ruin. Or so we are told.

A much happier conviction is expressed by Robert Fogel, a Nobel Prize-winning economist at the University of Chicago and a septuagenarian himself. America, he reminds us, is a very wealthy nation. The expanding longevity is not a financial burden but an enormous and underdeveloped asset. If US per capita income continues to grow at a rate of 1.5 percent a year, the country will have plenty of money to finance comfortable retirements and high-quality healthcare for all citizens, including those at the bottom of the wage ladder. When politicians talk about raising the Social Security retirement age to 70 in order to “save” the system, they are headed backward and against the tide of human aspirations. The average retirement age, Fogel observes, has been falling in recent decades by personal choice and is now around 63. Given proper financing arrangements, he expects the retirement age will eventually fall to as low as 55–allowing everyone to enjoy more leisure years and to explore the many dimensions of “spiritual development” or “self-realization,” as John Dewey called it.

“What then is the virtue of increasing spending on retirement and health rather than goods?” Fogel asked in his latest book, The Fourth Great Awakening and the Future of Egalitarianism (2000). “It is the virtue of providing consumers in rich countries with what they want most.” What people want is time–more time to enjoy life and learning, to focus on the virtuous aspects of one’s nature, to pursue social projects free of economic necessity, to engage their curiosity and self-knowledge or their political values. The great inequity in modern life, as Fogel provocatively puts it, is the “maldistribution of spiritual resources,” that is, the economic insecurity that prevents people from exploring life’s larger questions. Everyone could attain a fair share of liberating security, he asserts, if government undertook strategic interventions in their behalf.

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Fogel’s perspective is generally ignored by other economists, but sociologists and psychologists recognize his point in the changing behavior of retirees. The elderly are redefining leisure, finding “fun” in myriad activities that lend deeper meaning to their lives. An informal shadow university has grown up around the nation in which older people are both the students and the teachers. They do “volunteer vacationing” and “foster grandparenting.” They rehab old houses for the needy, serve as self-appointed environmental watchdogs or act as ombudsmen for neglected groups like indigent children or nursing-home patients. They dig into political issues with an informed tenacity that often withers politicians. In civic engagement, they are becoming counselors, critics, caregivers and mentors equipped with special advantages–the time and freedom to act, the knowledge and understanding gained only from the experience of living.

When the “largest generation” reaches retirement a few years from now, the baby boomers will doubtless alter the contours of society again, perhaps more profoundly than in their youth. Theodore Roszak, the historian who chronicled The Making of a Counter Culture thirty-six years ago, thinks boomers taking up caregiving and mentoring roles will inspire another wave of humanistic social values (perhaps expressed more maturely this time around). “More than merely surviving we will find ourselves gifted with the wits, the political savvy and the sheer weight of numbers to become a major force for change,” Roszak wrote in America the Wise (1998). “With us, history shifts its rhythm. It draws back from the frenzied pursuit of marketing novelties and technological turnover and assumes the measured pace of humane and sustainable values. We may live to see wisdom become a distinct possibility and compassion the reigning social ethic.” The “retired,” he predicts, will seek to become reintegrated with the working society and claim a larger role in its affairs. Some elderly may reclaim the ancient role of respected “elders” who keep alive society’s deeper truths and remind succeeding generations of their obligations to the nation’s longer term. None of these possibilities are likely to unfold, however, if the promise of economic security for retirement is eviscerated in the meantime.

Fogel’s optimism sounds eccentric amid the gloom and doom of the Social Security debate and the more threatening deterioration under way in private pensions and personal savings. Fogel skips over the snarled facts of current politics. He thinks big-picture and long-term. He won the Nobel Prize by producing unorthodox economic history that traced the deeper shifts in demographics and living conditions across generations, even centuries. His thinking is especially provocative because the conclusions collide with both left and right assumptions. Fogel is a secular Democrat, yet he extols the conservative evangelical awakening as a valuable social force. He sounds alternately conservative and liberal on economic issues, yet he thinks government should engineer a vast redistribution of financial wealth, from top to bottom, to insure equitable pensions for all.

Fogel’s solution is a new national pension system alongside Social Security–a universal “provident fund” that requires all workers to save a significant portion of their wage incomes every year to provide for their future. He proposes a savings rate of 14.7 percent (though taking Social Security benefits and taxes into account, a lower rate would suffice for a start). The contributions would be mandatory but set aside as true personal savings, not as a government tax. The accumulating nest eggs would belong to the individual workers and become a portable pension that goes with them if they change jobs, but the wealth would be invested for them through a broadly diversified pension fund. Employers would no longer be in charge (though they could still contribute to worker savings to attract employees). The government or independent private institutions would manage the money, investing conservatively in stocks, bonds and other income-generating assets while allowing workers only limited, generalized choices on their investment preferences.

The concept resembles the forced savings plans adopted in some Asian and Latin American countries, but Fogel’s favorite prototype is American: TIAA-CREF, the pension system that exists for nearly all college professors (a nonprofit institution founded in 1917 by Andrew Carnegie). Another model could be the government’s own Thrift Savings Plan, which manages savings wealth for federal employees. Lifelong healthcare, Fogel adds, could be guaranteed for all by setting aside another 9.8 percent from current incomes. “If you take the typical academic, we all have TIAA-CREF,” he explains. “The universities require of us that we invest anywhere from 12.5 to 17.5 percent of our salaries in a pension fund–mandatory–but it’s all in my name. I can leave it to whomever I want. It has entered my sense of well-being for many years. The fund has earned about 10 percent a year since the 1960s, so retirement is not a burden to the university.”

Obviously, people with low or even moderate incomes could not afford such savings rates, and even diligent savings from their low wages would not be enough to pay for either retirement or healthcare. Fogel has a straightforward solution: Tax the affluent to pay for the needy. A tax rate of 2 or 3 percent, applied progressively to families in the top half of income distribution, could finance the “provident fund” for those who can’t pay for themselves. “This is a problem, not of inadequate national resources, but of inequity,” he observes.

Fogel’s big thinking–a system of compulsory savings, with the federal government taking charge–sounds way too radical for this right-wing era, and probably even most Democrats would shy away from the concept. But keep Fogel’s solution in mind as we examine the sorry condition of retirement security. The current political debate is not even focused on the right “crisis,” much less on genuine solutions. It is not Social Security that’s financially threatened but healthcare and the other two pillars of retirement security–employer-run pension plans and the private savings of families. Many millions of baby boomers realize as they approach the “golden years” that they can’t afford to retire at all, much less retire early. They will keep working because they lack the wherewithal to stop. Retiring for them would mean a drastic fall in their standard of living. Fogel’s vision of expanding leisure and greater human fulfillment is actually receding at the moment. The time for big ideas is now.

Grasshoppers and Ants

When George W. Bush launched Social Security reform with his promise of new personalized savings accounts for everyone, he did not seem to grasp that most Americans already have such accounts. During the past generation tax-exempt 401(k) and IRA accounts–the individualized “defined contribution” approach–became the principal pension plan for working people, displacing the traditional company pension provided by employers who assume the risks and promise a “defined benefit” to workers at retirement. The do-it-yourself version of pensions is a flop, as many Americans have painfully learned. When older employees look at their monthly balance statements, they are more likely to experience fear than Bush’s romanticized thrill of individual risk-taking.

Picking stocks for themselves has left many employees, perhaps as many as 40-45 percent, without an adequate nest egg for retirement. When Bush explains further that he intends to divert trillions from Social Security to finance his “ownership society,” it makes people even more nervous. Social Security pays very modest average benefits–roughly equivalent to the federal minimum wage–but it is the last safety net. For nearly half of the private-sector workforce, it is the only safety net. The far more threatening problem is elsewhere–shrinking pensions, collapsed personal savings and soaring costs for health insurance.

The bleak reality is reflected in those 401(k) account balances. Of the 48 million families who hold one or more of the accounts, the median value of their savings is $27,000 (which means half of all families have less than $27,000). Among older workers on the brink of retiring (55 to 64 years old) who have personal accounts, the median value is $55,000. That’s only enough to buy an annuity that would pay $398 a month, far short of middle-class living standards. What’s strange and disturbing about their low accumulations is that these older workers have been investing during the best of times–the “super bull market” of soaring stock prices that lasted nearly twenty years. The Congressional Research Service summarized the sobering results: Median pension savings “would not by themselves provide an income in retirement that most people in the United States would find to be adequate.”

This grand experiment was launched nearly twenty-five years ago by Ronald Reagan, but with very little public debate because the pension changes were obscured by more immediate controversies–Reagan’s regressive tax cuts and massive budget deficits. His Treasury under secretary explained the reasoning: “The evidence of the past suggests that people do not behave like grasshoppers. They are much more like ants.” For lots of reasons, most Americans turned out not to be like the proverbial ants, storing food for winter. People either misjudged their future need for savings or couldn’t afford to put much aside or bet wrong in the stock market and got wiped out. But corporate managements turned out to be the true grasshoppers, living for the moment and ignoring the future. Companies took advantage of the 401(k) innovation to escape their traditional responsibility to employees. They dumped old defined-benefit pension plans and adopted the new version, which requires much smaller employer contributions and thereby reduces labor costs dramatically. Good for the bottom line, bad for the country’s future.

“The whole thinking was: Let’s relieve the employers of this burden and empower individuals,” explains Karen Ferguson, longtime director of the Pension Rights Center in Washington. “The problem is, it has failed–and failed miserably–and no one wants to say that.”

Pension protection is actually shrinking, despite the proliferation of 401(k) accounts and the alleged prosperity of the 1980s and ’90s. In the private sector, fewer employees participate in pension plans of any kind now than twenty years ago, down from 51 percent to 46 percent (the defined-benefit company pensions that once covered 53 percent now protect only 34 percent). The value of pension wealth, meanwhile, fell by 17 percent for workers in the middle and below, mainly because their voluntary savings were weak or nonexistent, yet soared for those at the top–“an upsurge in pension wealth inequality,” economist Edward Wolff of New York University observed.

In sum, pensions became less valuable. And fewer families have one. That helps explain why Bush’s plan encountered popular resistance. In these circumstances, whacking Social Security benefits or raising the retirement age does not sound like “reform.” But neither political party has yet summoned the nerve to acknowledge the implications of the failed experiment or to propose serious solutions.

The circumstances look even more ominous–the very opposite of Professor Fogel’s sunny vision–because personal savings also collapsed during the long, slow-motion weakening of pensions. Given the stagnating wages for hourly workers and easier access to credit, families typically managed to stay afloat by working more jobs and by borrowing more. Saving for the future was not an available option for many. In 1982 personal savings peaked at $480 billion, then began an epic decline. Last year the national total in personal savings was only $103 billion–down nearly 80 percent from twenty-five years ago. As Eugene Steuerle of the Urban Institute points out, the federal government now spends more money on tax subsidies to encourage the individual forms of pension savings–$115 billion last year–than Americans actually save.

The one potential bright spot in this story might be real estate–the family wealth that accumulates gradually through home ownership and the rising market value of houses. Given the current housing boom and runaway prices in the hotter urban markets, many families might salvage retirement plans by selling their homes and moving to less expensive dwellings. The trouble is, families have been living off that wealth–borrowing, almost dollar for dollar, against the rising price of their homes through equity-credit lines or refinanced mortgages. From 1999 through 2003, the value of family homes rose by a spectacular $3.3 trillion, but families’ actual equity in those properties changed little because mortgage borrowing rose nearly as fast.

Thus, people financed routine consumption by borrowing against their long-term assets–that’s real grasshopper behavior. And the situation could turn very ugly if the housing bubble pops and home prices fall. People will find themselves stuck paying off a mountain of debt on homes that are suddenly worth less than the mortgages. They will not only need to keep working; they might also be filing for bankruptcy.

How could this have happened in such a wealthy nation–especially during an era when stock prices were rising explosively? The basic explanations are familiar: rising inequality and reactionary economic policies, launched first by Reagan, then elaborated by Bush II and resisted only faintheartedly by Democrats. The corporate “social contract” was discarded; regressive tax-cutting rewarded capital and the well-to-do; numerous other measures fractured the broad middle class. The wages of hourly workers–80 percent of the private-sector workforce–have been essentially unchanged in terms of real purchasing power for three decades (no one in politics wants to talk about that, either). The political system continues to defer to the needs of corporations despite the torrent of financial scandals and extreme greed displayed by egomaniacal CEOs. All these factors contributed to the erosion of retirement security. Economist Teresa Ghilarducci, a pension authority at Notre Dame, remarks, “Just as wealth and income are being redistributed to the wealthy, so is leisure.”

In fact, Ghilarducci argues, allowing the pension system to deteriorate serves a long-term interest of business: avoiding future labor shortages when the baby-boom generation moves into retirement. “All this retirement policy is really a labor policy,” she asserts. “It’s motivated by these experts who say, Hey, wait, we’re going to need to do what we can to encourage people to work longer. A whole range of economists and elite opinion makers is talking about a labor shortage where, God forbid, wages would increase. That’s what they’re worried about–making sure there isn’t a corporate profit squeeze, that skill shortages and upward wage pressures are checked.”

This development is already lengthening working lives, she finds. The average retirement age, rather than gradually declining toward 55, as Fogel foresees, has turned around in the past few years and is slowly increasing. “I’m not against older people working if they want to,” Ghilarducci says. “I’m against policies that force them back into the workforce because they’ve lost their pensions or their healthcare costs have gone up.”

One need not question the sincerity of the right’s ideological convictions to see that their policy initiatives are also designed to benefit important political patrons. With the transition to 401(k) accounts, corporate employers were major winners. Ghilarducci’s examination of 700 companies over nearly two decades found that their annual pension contributions dropped by one third–from $2,140 to $1,404 per employee–as they shifted from defined-benefit pensions to the less expensive defined-contribution model. Not surprisingly, the traditional company pension began to disappear or shrink as large industrial companies hacked away at the uncompetitive costs. The number of younger workers with the traditional form of pension is much smaller and falling fast.

Wall Street banks and brokerages were big winners too, since they began competing for the millions of new “investors” with their individual stock accounts. This enormous influx of customers helped fuel the long stock-market boom and encouraged the exaggerated promises made by both corporations and financial firms. The overall economy was probably damaged too, because mutual funds competed for customers by going after rapid, short-term gains rather than focusing on the long-term investments financed by patient capital. When the stock-market illusions burst in 2000, the meltdown evaporated lots of retirement accounts too, especially for those innocent risk-takers who had bet their savings on NASDAQ’s high-flying tech stocks.

The most damning fact about the 401(k) experiment is that it has failed to fulfill the original purpose: boosting savings for ordinary Americans. Academic studies have confirmed that the personal accounts produced “very little net savings” or “statistically insignificant” gains. While every worker could participate in theory, the practical reality is that only the more affluent families could afford to take full advantage of the 401(k) tax break–sheltering their annual 401(k) contributions from income taxes. But typically they did so simply by moving money from other conventional savings accounts into the tax-exempt kind.

More affluent Americans thus reduced their income taxes, but their net savings did not actually increase. For two decades, the federal government has been heavily subsidizing “savings” by the people who needed no inducement because they were already saving. Think of it as welfare for the virtuously well-to-do. A rational government would phase out such a misconceived program. Bush is instead proposing to make the contradictions worse by adding still other tax-exempt savings vehicles designed to benefit the affluent.

The old system of defined-benefit pensions had many strengths by comparison, but it was never a solution to the national problem either. Even at their peak, the traditional corporate pensions left out half of the workforce. Larger companies, especially in unionized industrial sectors, provided strong benefits for their employees, responding to labor’s bargaining demands and to attract well-qualified people. But the millions of very small firms, where more Americans work, almost never offered pensions. The burden either seemed too costly or too complicated to administer. Generally, their workers are the folks who depend solely on Social Security.

The corporate pensions are also not portable (a problem the individual accounts were supposed to solve). And pension law gives corporate managers ample latitude to game their pension funds to enhance the company’s bottom line. Stories of elderly retirees stranded by their old employers are now commonplace: broken promises on healthcare and other benefits that go unpunished. Instead of accumulating larger surpluses during the good times, the corporations often did the opposite, leaving their pension funds severely underfunded for the bad times, when shortfalls couldn’t be overcome. Employees have no representatives to speak for them in the decision-making. If a corporate pension fund goes belly up, its liabilities are dumped on the government’s insurance agency, which is getting strapped itself.

Alogical and achievable solution exists to correct this mess. Government should create a new hybrid pension that combines the best aspects of defined-benefit and defined-contribution versions–one that requires all workers to save for the future and no longer relies on the “good will” of employers. Given modern employment patterns, workers do need a portable pension that stays with them, job to job. But their voluntary savings are simply too small and erratic–too vulnerable to manipulation by financial brokers–to produce secure results in the stock-market casino. Either they get lured into wild gambles or they park their savings in mutual funds that gouge them with inflated fees and commissions while catering to the corporations that are the funds’ largest customers (this conflict of interest between large and small customers is endemic to the US financial system; guess who loses). The employees’ money will produce far more reliable accumulations if it is invested for them by professionals at a major independent pension fund that works only for them.

The fundamental truth (well understood among experts) is that individualized accounts can never match the investment returns of a large common fund, broadly diversified and soundly managed, because the pension fund is able to average its results over a very long time span, thirty years or more. A few wise guys might beat the casino odds, but the broad herd of small investors will always be captive to the random luck of bad timing and their own ignorance. The right wing’s celebration of individual risk-taking in financial markets is like inviting sheep to the slaughter.

The super bull market is over. Its gorgeous returns will not return for many years, maybe many decades. But a very large, diversified pension fund–managed solely in the interests of its contributors–provides the vehicle for “shared luck.” It can smooth out the ups and downs among all participants, young and old, lucky and unlucky. It can invest for long-term economic development rather than chase stock-market fads. Good returns for retirees, good results for the economy.

These are the very qualities Professor Fogel envisions. They describe trustworthy pension systems, like TIAA-CREF, which reliably serves many thousands of individual employees (teachers and professors) who are scattered across many different employers (schools and universities). The present reform debate is not thinking this way. Collective action is out of fashion, especially if the government is involved. Significant reform would require institution-building. The transition would pose many technical difficulties. “There are obstacles, but I don’t think that’s the problem,” Ghilarducci says. “The obstacle is imagination.”

Pro-Life Pension Reform

The Pension Rights Center just conducted a year-long “conversation on coverage” that pulled together experts from business and labor, the insurance industry, Wall Street finance, academia, AARP and other interested sectors. The workshop sessions produced a long list of worthy ideas for patching up the broken system, but that was the problem: The proposals basically involved incremental tinkering with the status quo, not universal, mandatory solutions. To get all these diverse interests to join the conversation, Karen Ferguson confides, the center had to stipulate that “mandatory” would not be discussed.

“The bottom line is that the companies always have the upper hand, even though they’ve gotten huge subsidies and tax benefits,” she explains. “The system is voluntary, so companies can always opt out.” Indeed, the politics of pension reform is usually a discussion about what new favors and concessions should be granted to employers to get them to do the “right thing” for their employees. This political logic led to the current failure. “Voluntary” is a loser, as the past twenty years amply demonstrated, because it gives companies controlling leverage over what is possible. And even well-intentioned executives will always have to choose between the company’s self-interest and its employees (guess who usually loses). Only the government has the reach and power to design and oversee a pension system that truly serves all. During the past generation, most corporations discarded their obligations under the old social contract. It seems only fair they should forfeit political control too.

Plausible plans in addition to Fogel’s do exist that offer genuine solutions. A universal savings system that covers everyone because it is mandatory could prove to be as durable (and popular) as Social Security. It balances equity by subsidizing the savings of lower-income workers. It creates authentic individual ownership and incentives to save more for the future, consume less in the present. It operates free of Wall Street profiteers and under government supervision, adhering to well-established principles of sound investing. Employers could be discouraged from further abandoning their obligations by penalties in the tax code. Many other nations, large and small and far less wealthy, have created such systems. Americans would need to craft their own distinctive version.

One promising example, designed by economist Christian Weller for the Economic Policy Institute, proposes a modest savings rate of 3 percent of wages, but combined with the existing Social Security benefits, it would approach the level of retirement security envisioned by Fogel. The government would contribute substantial savings for low earners and also match additional contributions made by the workers or their employers. Weller estimates this would cost around $48 billion a year–less than half the federal tax subsidy now devoted to all pension plans. Weller’s design is robustly equitable, scaled to help the bottom rungs most and top income earners least. Combined with Social Security, low earners (wages of $24,000 or less) would enjoy a pension that replaces 83 percent of their peak working wages. Average earners would get 60 percent replacement, high earners only 48 percent. This makes sense, because higher-income families have much greater opportunity to augment pensions with other sources of income and savings. The working poor do not.

Essentially, Weller has updated and expanded a mandatory savings plan that was proposed nearly twenty-five years ago–a last gasp from the Carter Administration. Reagan’s election and laissez-faire politics snuffed the idea. While still modest in scale, Weller’s design represents a meaningful start toward Fogel’s larger vision of a 15 percent savings rate. Since the Social Security tax now collects 12.6 percent of wages jointly from workers and employers, it is not plausible at this point to add another 15 percent to labor costs for pension savings. However, as the new pension system matures and public confidence is established, a gradual transition can be pursued that adds little by little to the personal savings rate, offset by equivalent reductions in the payroll tax for Social Security–thus yielding greater savings and lower taxes. Both government systems would continue in place, one as the fundamental safety net of social insurance, the other as the universal, expanding pillar for comfortable retirement.

Ghilarducci thinks much of the accumulating wealth could be stored and invested by large private pension funds, organized by unions or other groups for workers at multiple employers (much like TIAA-CREF’s role for universities). A successful existing model is the unified pension systems for the building and construction trades. Co-managed by unions and companies, they encourage industry and labor to collaborate on joint training and other productivity-enhancing endeavors that can raise the quality of work and wages.

While most politicians don’t dare embrace a “mandatory” solution–not yet, anyway–it is not self-evident that ordinary Americans would reject one, if properly educated about the alternatives. Most people are conflicted. They know they need to save more–retirement is a very meaningful investment for them–but it’s very hard to accomplish, given the competing pressures. They like the concept of personal accounts but are also aware of their vulnerability as amateur investors. In her conversations with union presidents, Ghilarducci finds they are more in favor of an “add on” national pension than raising the payroll tax for Social Security. “You can sell workers if their name is on it,” she concludes. “If you had a system that says you must contribute 3 percent of wages to your mandatory savings account, you would actually have two-thirds of the workers grateful that they are being forced to save. You wouldn’t get that if they were forced to pay another 3 percent in taxes into Social Security.”

The retirement question–choices of mandatory or voluntary, universal or incremental–embodies a classic dilemma often facing liberal politics. Do reformers pursue the larger, more provocative approach that invites greater resistance but would fundamentally solve the problem? Or do they opt for smaller, safer measures that have a better chance of adoption and will demonstrate good intentions, if not a genuine remedy for society? For several decades, it seems obvious, most Democrats have chosen the side of caution: thinking small, offering symbolic gestures, avoiding fights over fundamental solutions. One can see where this strategy has gotten the party. The gestures are no longer taken seriously, since they don’t lead anywhere. The public no longer associates Democrats with big ideas or principled commitments to authentic reform. We await incautious politicians with the courage to pursue their unfashionable convictions.